Investing directly in shares may be the most obvious way of putting money into the stock market but for most investors it is rarely the most appropriate, writes Paul Durman.

Most will probably be better off buying into a professionally-managed investment fund such as a unit trust or an investment trust rather than a portfolio of shares. These are often available with the tax-free wrapping of a personal equity plan (PEP).

Unit trusts and investment trusts are based on the same principle. By pooling their money in a single fund, small investors can hold a much wider spread of investments than they could afford individually. The manager of the fund, which often runs into tens or even hundreds of millions of pounds, will invest that money, and spread the investment risk, across 50 or more shares.

Investing in a unit or investment trust will not protect you from all the vicissitudes of the stock market. If there is a market-wide collapse in share prices, as happened in the October 1987 crash, you are unlikely to escape unscathed. But at least you have the comfort of knowing that you will not be ruined because of one bad investment.

Another advantage is that a professional fund manager is constantly watching over the portfolio, buying and selling shares in the light of the changing economic environment. Once again, however, a professional manager is no guarantee of good results. Care needs to be taken to select funds run by firms with good reputations.

Unit trusts are the simpler of the two sorts of pooled fund. They are sub-divided into units, whose price changes to reflect the changing price of the shares held by the fund.

Investment trusts are stock market-quoted companies in their own right, and investors can buy and sell their shares as they would those of any other. The main complication with investment trusts is the discount that often exists between the share price and "net asset value", the value of the investments held by the fund. The share price is determined by the demand for the shares in the market, and if it is substantially less than NAV, the trust may be regarded as cheap, and may even attract a takeover bid.

The same fund managers often run unit and investment trusts. The question of which are better is the subject of debate. Over the past 10 years investment trusts have often seemed to have the better performance records, but this is largely because discounts have narrowed.

Unit and investment trusts that invest at least 50 per cent of their money in European Union stock markets are eligible for a full pounds 6,000 investment from a personal equity plan. PEPs have become popular, and the acronym is often used as if it was synonymous with an investment fund. Strictly, the PEP is only the tax shelter. PEP investments escape income and capital gains tax but since most investors do not pay CGT, the main benefit is tax-free income.

Many fund management companies charge no more for "Pepped" unit trusts than they do for the basic fund.

If you do decide to invest directly in shares, be careful to diversify your risks. Many people gained their first experience of investing in shares through government privatisations. This was a highly unusual form of equity investment, since investors were virtually guaranteed a quick profit by underpricing. Privatised firms are typically big companies with secure earnings, and most enjoy the benefits of a near-monopoly and enormous scope for cost-savings. Few conventional private sector companies are so privileged.